The Mystery of Mutual Insurers in Lawyers Professional Liability Insurance

Abstract

Large law firms in the U.S. rely heavily on lawyers-only mutual insurers to manage their malpractice risks. Yet, under classic economic theory, mutual insurers should not be able to compete with stock insurers, at least absent a market failure. Mutuals have less access to capital and thus less ability to spread risk. Also, mutuals demand much more law firm partner time. Our research into the lawyers’ professional liability (LPL) insurance market makes three contributions. First, while we find evidence consistent with the traditional explanations for mutual insurance — market failures related to moral hazard and adverse selection and a problem with long-term contracting, we also provide a new autonomy explanation. Many lawyers, and presumably other professionals, perceive that mutual insurance promotes professional independence in the face of the social control imposed by liability and insurance. Second, we crack open the windows on a secretive aspect of law firm risk management, revealing the variable, hybrid nature of LPL mutual insurance arrangements. Third, we reframe the scholarly understanding of the relationship between organizational forms. The corporate law and insurance literature typically views mutual and stock insurers solely as competitors. We show that they also play complementary roles, as all of these mutual insurers engage extensively with commercial insurers through reinsurance or excess insurance. At least in this context, mutual insurance is not an alternative to stock insurance, but rather a way to manage access to the powerful risk distributing potential of stock insurance. Indeed, the availability of mutual insurance may favorably affect the behavior of stock insurance companies even outside of their relationships with the mutual insurers. Accordingly, our research suggests that lawyers’ participation in their mutual insurers provides benefits not only to their firms, but also to the legal profession.